Cross-border Capital Tax Required for Hot Money

The experts suggested that cross-border capital tax should be imposed on the international hot money.

When the China is carrying out the measures of adjusting and controlling macro economy, fighting against inflation and prohibiting the appreciation of RMB, the government make several changes to the taxation system, including lowering the tax for small- and medium-sized enterprises to release them from the operational stress of more expensive raw materials and labor force, improving the minimal salary level to increase the income of ordinary people, heightening the bottom line for individual income tax to free more families from this kind of tax and accelerating the reform to resource tax to establish the market-oriented pricing system for resources.

Apart from this, Song Yixin, partner of Shanghai New Hope Law Firm, believes that it is necessary to impose cross-border capital tax over the international hot money and flowing capital.

The international hot money refers to the international flowing capital that mainly pursues the short-term profit with the interest rate changes and anticipation of currency appreciation. The financial supervision and management department of each country watches out for international hot money because sometimes it can pose great damage to a country’s economic and financial system. In China, enhancing the management of the short-term capital flow is an important task as well. Generally speaking, there are three ways to achieve the goal: a), reviewing the regular projects which receive this kind of capital and controlling the arbitrage trade based on RMB appreciation; b), managing and controlling the illegal short-term capital flow in the name of investment; and c), supervising the real purpose of this kind of capital when it flows inward and punish the wrongdoers.

In Song Yixon’s opinion, the three methods are within the range of administration. China can also formulate laws to impose cross-border capital tax on the international hot money. This can effectively prevent a large amount of hot money flowing into China and affecting its financial system. But this can not work on the international hot money that flows into China in illegal methods. Punishments in both administrative and legal levels are needed to deal with this.

The cross-border capital tax can date back to a long while ago. In July 1963, the US government imposes the interest balance tax over the foreign bonds bought by American citizens to maintain the international status of US dollars. In February 1964, the one-to-three-year bonds issued by American financial institutions to foreigners were also included into the scope of interest balance tax.

From the middle 1990s, some emerging economies began to impose various kinds of cross-border capital tax to control the capital flow. During the Asian financial crisis which broke out in 1997, Malaysia decided to impose tax on the return on foreign investment in February 1999 at the rate of 30%. One year later the rate was lowered to 10% and remained stable from then on. This successfully stabilized the financial system of Malaysia.

In November 1993, Brazil also began to impose tax the foreign capital. 3% tax was imposed on the loans lent to foreigners. 5% tax was imposed on the revenue of foreign investment into the Brazilian fixed securities. In 2010, in order to prohibit the appreciation of Brazilian currency Real, Brazilian government imposed 2% tax on the bonds and securities bought by foreign investors.

In December 2010, Korean government wants cool the frequent capital flow by imposing  tax on the revenue of foreign investors from the bond interest (14% rate) and investment return (20% rate).

In addition, when the international financial crisis broke out, the leaders of Germany and France also ask for imposing cross-border capital tax. During the Pittsburg Summit of the Group 20, Germany and France collaboratively put forward the idea of “tax of global financial trades”, aiming to reduce the speculative trades in the world and unify the tax rate for the worldwide foreign exchange spot conversion. It is also called Tobin, because it was put forward by the Nobel Laureate economist James Tobin.

From the aforementioned texts we found that the tax on cross-border capital is divided into two kinds – the tax on the revenue and the tax on the trading volume

The tax on the revenue aims at non-institutional investors. The government can fix the tax rate according to the ambience to restrain the flow of a certain kind of capital. The tax on the trading volume, which aims at the big international trades, can help to restrain speculative short-term investment.

Apart from the aforementioned two methods, there is another cross-border capital tax called Unremunerated Reserve Requirement (URR). Concretely, the cross-border investor deposits a certain amount of RMB or foreign currencies to in China’s central bank based on the investment amount. There is no interest for these deposits. Its function is same to the financial trade tax. The administration department controls the capital inflow by changing the URR and the term of the deposits. But this method has tiny influence upon the capital outflow. It works indirectly and removes the opportunities for arbitrage.

For example, in the 1970s, Germany and the Switzerland carried out the zero interest policy for the non-residential deposits. In the middle 1990s, China began to ask for the bail for remitting profits. In 1991, Chile also implemented URR, which initially aimed at the loans lent to foreigners. The target kept changing according to the financial situation.

Therefore, when confronted with the impact of the short-term capital inflow, China should adopt cross-border capital tax to maintain the stability of its financial and economic system. Presently, China adopts strict management rules for the capital flow. Cross-border capital tax is only working as a supportive method.

In Song Yixin’s opinion, the URR is suitable for all kinds of debt-related capital inflow. The central bank can adjust the term and rate of the URR according to the economic situation. Meanwhile, Song Yixin suggests reforming to the qualified foreign institutional investors (QFII) and canceling the examination process for QFII when the time is OK.